EDGAR Breach: Clayton addressed therecently disclosed breach of the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system for corporate filings, explaining the steps the SEC has taken to investigate the breach and mitigate future incidents. Clayton stated that he has begun the search for a Chief Risk Officer to assess the SEC’s total risk profile.

Best Interest Standard: Clayton discussed coordination between the SEC and Department of Labor (DOL) on developing a best interest standard for broker-dealers, thanking Secretary Acosta for reaching out to the SEC on the issue. Rep. Ann Wagner (R-Mo.) discussed her bill, H.R. 3857, which would direct the SEC to create a uniform best-interest standard for broker-dealers.

Public Capital Markets: The hearing provided Clayton an opportunity to discuss his views on the declining total number of public companies and the low numbers of IPOs in recent years.He fielded questions throughout the hearing on ways the SEC can improve the environmentfor public companies.

MiFID II: During the hearing, several Representatives asked Clayton about the European Union’s (EU) Markets in Financial Instruments Directive (MiFID) II generally and a bout that Directive’s rules on research payments unbundling. Clayton said it was his desire for the “current model to continue” in the United States and said the SEC is putting together a set of proposals to prevent the “importation” of the EU model of paying for research.

Consolidated Audit Trail: Questions were frequently asked about the Consolidated Audit Trail (CAT)’s implementation. Representatives expressed concern that data collected as part of CAT would not be secure from hackers, but Clayton said in his oral testimony that he did not want to delay the implementation of market surveillance programs despite the EDGAR hack.

In his opening statement, Chairman Hensarling noted that this was Chairman Jay Clayton’s first appearance before the committee, and “applauded” the changes the Chairman has made so far in his tenure and the renewed commitment of the Securities and Exchange Commission (SEC) to facilitating capital formation to help small businesses. Hensarling also highlighted Clayton’s public comments on “the need to reverse the trend of declining initial public offerings” (IPOs). Hensarling stated that the SEC should continue to explore ways to “simplify its disclosure regime and return to the concept of materiality,” saying that securities laws are not the “appropriate avenue” to pursue ideological agendas that can harm economic opportunities. Hensarling also noted that under the last administration the SEC “dropped the ball” on the fiduciary rule, allowing the Department of Labor (DOL) to “insert itself” into the SEC’s jurisdiction, which “must be reversed.”

Hensarling also addressed the 2016 data breach of the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system, in which non-public information was compromised. Hensarling expressed concern about the implications of the breach with the upcoming implementation of the Consolidated Audit Trail (CAT), which will serve as a central repository for trading data, and urged the SEC to delay implementation until it can ensure safeguards and internal controls are in place to effectively protect the CAT data.

Rep. Carolyn Maloney (D-N.Y.)

In her opening statement, Maloney stated that one of the U.S.’s “greatest assets” is its economic strength, including strong capital markets. Maloney noted that confidence in the markets must be maintained, and it is the duty of the SEC to oversee those markets, making it one of the “most important regulators in the world.” Maloney said that the SEC must “constantly evolve and adapt” to respond to new innovations and trends in the markets, and modernize its regulatory regime to respond to new risks. Maloney expressed concern about the recent EDGAR breach, as well as the Equifax breach, noting that while Clayton has been transparent and proactive in his response, there are still questions about the security of the system.

Rep. Bill Huizenga (R-Mich.)

In his opening statement, Huizenga expressed concern about the decline of IPOs, which results in fewer investment opportunities for main street investors who rely on capital markets. Huizenga noted that these investors should have the “opportunity to receive the greatest return on their investment” and “invest in a better future.”

Rep. Dan Kildee (D-Mich.)

In his opening statement, Kildee stated that it is “critical” the SEC examine the trades made by Equifax executives to determine if individuals “took advantage” of non-public knowledge that was not disclosed for another six weeks. Kildee urged the SEC to clarify to companies that when a breach is material, it must be disclosed to the public, saying that six weeks between discovery and disclosure is too long. Kildee noted that the SEC plays a “critical role” in ensuring the safety and soundness of our markets, and must help restore public confidence. Kildee also addressed the disclosure of political contributions by publicly traded companies, saying that the Supreme Court Citizens United decision “opened the floodgates” of political spending.

Testimony

The Honorable Jay Clayton, Chairman, U.S. Securities and Exchange Commission

In his testimony, Clayton said that so far in his five months at the SEC, he has focused largely on agency operations, and that going forward there must be additional focus on cybersecurity, retail investor protection, market integrity, and capital formation. Clayton addressed the recently disclosed breach of the EDGAR system, saying that the breach provided access to non-public information that may have been used for illicit trading. Clayton said the breach has led to an independent review by the Office of the Inspector General, a Division of Enforcement investigation into possible insider trading, a focused review and uplift of the EDGAR system, and an assessment and uplift of general cybersecurity efforts, including the CAT. Clayton also noted his upcoming Regulatory Flexibility Act Agenda, including an open meeting scheduled to discuss a rule proposal to modernize and simplify disclosure requirements in Regulation S-K.

Question & Answer

Consolidated Audit Trail (CAT)

Hensarling noted that the CAT is due to go live in a matter of weeks, and asked Clayton to assure the committee that the CAT is ready for “prime time.” Clayton said that the self-regulatory organizations (SROs) are developing the CAT, along with Thesys, but that there are still questions about the CAT’s security that need to be answered.

Huizenga asked Clayton if he is waiting for the SROs who designed the CAT to declare that CAT is not ready, or if that will be a decision by the Commission. Clayton said the SROs have an obligation to get the CAT up and running and that it is their decision.

Rep. Blaine Luetkeyemer (R-Mo.) asked whether it is necessary to collect personally identifiable information (PII) in CAT. Clayton said that the SEC will only collect PII if it is necessary. Rep. Joyce Beatty (D-Ohio) asked a similar question, and Clayton defended the collection of PII as necessary to identify insider trading that may not be apparent from raw trade data alone.

Rep. Randy Hultgren (R-Ill.) asked Clayton for his view on the implementation of the CAT in light of the SEC’s EDGAR hack, and referenced a recent editorial in the Wall Street Journal that was critical of the CAT and previous SEC-led data collection efforts. Hultgren also asked if Thesys would be prepared for the launch of the CAT in November, and if Thesys is taking the necessary steps to protect the CAT’s information. Clayton said that the SROs are the “first line” of data security who are responsible for overseeing Thesys, and that he would “press them” on whether the security procedures are in place for the CAT.

Rep. Jim Himes (D-Conn.) also expressed concern about the SEC’s collection of data.

Public Capital Markets

Hensarling noted his concern about declining IPO markets, asking what “chilling effects” regulations have had on the market and why it is important to “invigorate” the market. Clayton responded that the choices available to retail investors are diminishing because the number of public companies is diminishing, and it is costly to invest in private investments. Clayton stated that there is currently a “one-size fits-all” model in the regulatory regime, and regulators should be looking into the possibilities of the scaled system of regulation in order to increase the “opportunity for main street investors to invest in the growth of America.”

Huizenga asked if a “holistic review” of equity market structure is necessary, and if such a review should focus on Reg NMS. Clayton said it’s important to review Reg NMS but that the Commission should consider broader questions as well.

Rep. Mia Love (R-Utah) talked about the worrying trend of fewer small companies going public, and asked Clayton for an update on the SEC’s tick size pilot program, which is exploring whether larger tick sizes can improve trading of small cap stocks. Clayton said that the results have been mixed, with some companies experiencing increasing volume and liquidity, and others not. Clayton said the program may need to run longer due to behavior in the marketplace being slow to change. Love asked if the reduction in tick sizes has contributed to a decline in IPOs, and Clayton said it could be a factor and that the SEC should find a way to improve trading for small equities. Clayton said he hoped that the tick size and access fee pilots will provide the SEC with information necessary to improve the trading of these stocks.

Rep. Keith Ellison (D-Minn.) expressed concern about market concentration, and asked Clayton if acquisitions of small companies by large ones are driving the declining total of public companies. Clayton agreed it was a factor, and that many companies sell because it is “the path of least resistance.”

Himes discussed his belief that the 7 percent spread on IPOs across deal size and over time is evidence of a lack of competition, or possibly collusion, in the IPO launch business. Himes asked Clayton if he thought there was sufficient “probable cause” for the SEC to launch an investigation on the topic. Clayton said, “it’s worth looking at” but declined to elaborate.

Rep. Tom Emmer (R-Minn.) asked Clayton for his thoughts on creating a venture exchange for smaller companies. Clayton said that he is interested in the idea but that he has not consulted with the other Commissioners about the issue yet.

EDGAR Breach

The recently disclosed breach of the SEC’s EDGAR system for corporate filings was the subject of questions from multiple Representatives throughout the hearing. Clayton stated that though the investigation is ongoing, the SEC is not waiting until it is completed to act to improve the SEC’s cyber defense systems, and that he has begun the search for a Chief Risk Officer to oversee both cyber and general risks.

Rep. Ed Royce (R-Calif.) asked Clayton to describe the possible responsibilities of the SEC’s future Chief Risk Officer. Clayton said that the role will be critical for assessing the SEC’s total risk profile. Clayton said that because the agency is “constantly under attack,” he cannot be notified of every attempt, but there must be mechanisms in place to assess the significance of attacks and elevate them appropriately. Clayton declined to comment on some specifics, including the timeline of the discovery of the breach and the identity of the perpetrators, saying it could jeopardize the ongoing investigation.

Markets in Financial Instruments Directive (MiFID II)

Huizenga noted that many market participants are concerned about the European Union’s (EU) Markets in Financial Instruments Directive (MiFID) II rules on research payments unbundling, and asked if the SEC will provide relief from these rules. Clayton said it is his desire for the “current model to continue” and that the SEC is putting together a set of proposals to prevent the “importation” of the EU model.

Rep. Dennis Ross (R-Fla.) asked if MiFID II’s unbundling would hurt small cap equities. Clayton said that “many people” are worried about unbundling and reiterated that he does not want the EU model to be “imported.” Clayton also said the SEC is working on a “patchwork” of proposals to provide “exemptive relief.”

Best Interest Standard

Rep. Ann Wagner (R-Mo.) discussed her bill, H.R. 3857, which would direct the SEC to create a uniform best interest standard for broker-dealers, and asked Clayton if it is important to prevent two best interest-standards (one from the DOL, the other from the SEC) from being active at the same time. Clayton said that dual standards “make no sense” and thanked DOL Secretary Alex Acosta for reaching out to work on the issue. Wagner also asked about a recent law passed by the state of Nevada that created a state-level broker-dealer best-interest standard, and if he is concerned about the creation of a “patchwork” of state-level standards. Clayton said he was concerned.

Rep John Delaney (D-Md.) asked if the DOL’s rule is a good rule. Clayton said it is too soon to tell, and that while the “words” were good, it is important to make sure the rule is not implemented in a way that restricts access to financial advice.

Rep. Claudia Tenney (R-N.Y.) asked about the SEC’s relationship with the DOL and efforts to revise and implement a best-interest standard. Clayton said the SEC and DOL would have to “put our heads together” and that the SEC will benefit from the thought the DOL has put into the rule thus far.

Access Fee Pilot

Maloney noted that there is market participant interest in a zero-rebate bucket being included in the Access Fee Pilot program. Clayton said a zero rebate is under consideration.

Self-Regulatory Organizations (SROs)

Rep. David Scott (D-Ga.) asked Clayton about a bill he cosponsored, HR 3555 , which he said would clarify the definition of the term “facility” and allow exchanges, like the New York Stock Exchange (NYSE), more “breathing room” to operate. Clayton said he is aware of the legislation and said that the SEC is considering its regulatory approach to the NYSE and other exchanges, and that he does not want the SEC to go beyond its “bread and butter” regulatory requirements.

Diversity and Inclusion

Rep. Greg Meeks (D-N.Y.) asked Clayton if board diversity in public companies should be disclosed to investors. Clayton said the SEC was “looking at” how to best collect this information and that he is worried about “proscribed disclosure.”

Beatty asked about the SEC’s implementation of Dodd-Frank’s Section 342, which requires reporting by financial regulators on diversity in hiring practices. Clayton said that he believes the SEC is doing “pretty well” across the Commission outside of the Commission’s leadership, and that he has read the report produced by the SEC’s Office of Minority and Women Inclusion (OMWI).

Initial Coin Offerings/Financial Technology (FinTech)

Rep. Ed Perlmutter (D-Colo.) asked Clayton for his thoughts on initial coin offerings (ICOs). Clayton explained that “it’s a new thing that has some good,” but is also a “new avenue for fraud.” He continued that the Enforcement Division is aware that ICOs are a “prime area for pump and dump” due to being electronic and anonymous.

Rep. Bill Foster (D-Ill.) asked Clayton whether he believes ICOs constitute a legitimate capital formation tool, or if they are being used to circumvent securities laws. Clayton said his “view” is that there is “not much of a distinction” between ICOs and traditional securities.

Rep. Patrick McHenry (R-N.C.) also asked Clayton about his views on ICOs, and Clayton said the first step is determining whether a token is a security, and if the sale of that security complies with the SEC’s requirements or meets a relevant exemption.

Asset Manager SIFI Designation

Ross noted that the Financial Stability Oversight Council (FSOC) had previously considered whether to designate asset managers as systemically important financial institutions (SIFIs). Ross asked if the SEC is “competent” to regulate asset managers without the FSOC or the SIFI designation, and Clayton agreed that the SEC is the best regulator for asset managers.

Disclosure

Rep. Ed Royce (R-Calif.) said that consumers and investors need to know when cyber-attacks on businesses put their money at risk, and asked if the disclosure standards today are sufficient to require cyberattack notifications, or if issuers should be explicitly required to disclose these events. Clayton agreed that corporate cyber risk profiles are very important for investors, but stopped short of endorsing a specific change to the disclosure regime.

Delaney asked Clayton if companies should be required to disclose the impact on their business of climate change risks. Clayton did not endorse this approach, but said that companies that could be affected by climate should disclose anything material.

Rule 30e-3

Rep. Brad Sherman (D-Calif.) voiced his support for proposed Rule 30e-3, which would modernize financial disclosures by delivering them electronically, and asked when the proposal will be completed, to which Clayton replied that the Commission is working on it.

Rep. Bruce Poliquin (R-Maine) was critical of Rule 30e-3, explaining that seniors and those living in rural areas without broadband access will be disadvantaged by electronic disclosure.

Fixed Income Market Structure Advisory Committee (FIMSAC)

Hultgren thanked Clayton for setting up a Fixed Income Market Advisory Committee (FIMSAC) and asked if Clayton would consider having small dealers represented on that Committee. Clayton said he did not want the FIMSAC to consist only of large firms.

Finders

Rep. Ted Budd (R-N.C.) asked if the SEC could clarify the regulatory uncertainty that he said surrounds finders. Clayton said he “fundamentally agrees” that if someone finds investments on an ad-hoc basis only, that person should not be regulated as a broker-dealer, but conceded that drawing this distinction could be difficult.

Fund Management

Rep. Andy Barr (R-Ky.) asked about a 2016 SEC rule that requires open-end fund managers to report monthly on the securities that they hold in portfolio. Barr noted that many funds are concerned the data will not be secure from hackers. Clayton said that if this data was leaked it could allow hackers to trade against asset managers, and that the SEC is exploring data security around these reports.

Chicago Stock Exchange

Pittenger asked about the SEC freezing the purchase of the Chicago Stock Exchange to a Chinese-affiliated firm, to which Clayton explained that the Commission will ultimately decide on the issue, as the recommendation was previously made at the staff level. He added that he wants to finalize the issue “sooner rather than later.”

Regulatory ReviewRep. Keith Rothfus (R-Pa.) asked about the regulatory review the SEC is conducting, to which Clayton replied that the Commission is looking for ways to make regulations less and expensive and burdensome while maintaining investor protection.

Current Expected Credit Loss Standard

Rothfus then asked if the Commission will be reviewing the current expected credit loss (CECL) standard accounting rule. Clayton replied that he has heard and understands the concerns from community and regional banks regarding CECL and how it could impact capital, and that they are maintaining dialogue with the banking regulators.

Insider TradingHimes stressed that there should be legislation that makes insider trading illegal, and Congress should take the lead rather than the Commission, to which Clayton replied that while he is happy to engage with Congress, he is confident that the SEC can “do a good job.”